6 reasons why infrastructure is becoming popular
Infrastructure has become increasingly popular with investors looking to improve the resilience and diversification of their portfolio via exposure to an alternative asset class
Infrastructure can be broadly defined as being assets that provide, or facilitate the provision of, essential services that support economic growth and underpin the day-to-day operation of society. We all utilise infrastructure assets every day - when we use electricity, gas or water, when we go to schools or hospitals, and when we travel by road, rail or air.
This article looks some of the typical characteristics of infrastructure assets and how it can complement a traditional portfolio.
Predictable cash flows
Infrastructure assets tend to have a high level of visibility and security with regards to future cash flows. Their revenues are often underpinned by regulation or by long term contracts with highly creditworthy counterparties (which can often include governments). This means infrastructure can provide investors with consistent and attractive income yields, which is something many investors are looking for in the current low-income environment.
Revenues generated by infrastructure assets are often linked to inflation. This inflation linkage can come about because rates of return set by regulators for regulated infrastructure assets are often linked to future inflation, or under the provisions of a long-term contract. This alignment with future inflation makes these infrastructure assets attractive to long–term investors who are looking to protect against the erosion of the value of their money over time by inflation.
Sustainable competitive advantage
In many instances infrastructure assets enjoy a monopoly, or operate in markets where the barriers to entry are high. This means that the assets cannot be easily replicated, and that they are often free from the competitive pressures that are faced by many more traditional companies.
Low operating expenses as a percentage of revenue
The primary cost of an infrastructure asset is its construction. Once operational, an asset typically has low operating and maintenance costs.
An infrastructure asset will generally have a long economically useful life. For example, many assets have lives of 30-year plus and, in some cases, much longer. Regular maintenance ensures that assets are able to operate for their entire expected useful life.
Infrastructure assets are essential to the operation of our society, meaning that they are often less influenced by economic factors than many other businesses. This feature can help infrastructure to deliver steady returns through market cycles.
What are the risks?
Of course, as with any investment, it is critical to consider the risks. The upfront and ongoing identification and management of risks is fundamental to successful infrastructure investment. Typical risks that infrastructure assets may face can include interest rate sensitivity and refinancing risk, regulatory and political risk, liquidity, as well as asset-specific operating risks.
How can infrastructure fit into your portfolio?
In recent times we have seen significant levels of market volatility. The defensive characteristics of the infrastructure asset class means it tends to exhibit lower levels of volatility relative to many other asset classes, and is well placed to deliver steady returns through market cycles.
In addition given the low correlation between infrastructure and other asset classes, such as the broader global share market and fixed interest, an allocation to the infrastructure asset class can help investors manage risk in their portfolios through delivering the important benefit of diversification.
Finally, the predictable and stable cash generative ability of infrastructure assets means it is likely that the assets can return consistent and attractive cash yields to investors, along with the potential for capital growth.
The need for infrastructure investment is a never-ending cycle
Investment in infrastructure helps stimulate sustainable long-term economic growth which then creates a further need for infrastructure. Many consultants have completed extensive research into global infrastructure investment needs, demonstrating the significant amount required. McKinsey forecasts that US$57 trillion investment is required to be invested in core infrastructure alone by 2030 - just to keep up with expected economic growth. Governments who are already heavily indebted can’t afford to spend the money themselves. So, infrastructure companies have to be part of the solution to fund this shortfall and are well positioned to benefit from attractive investment opportunities.
Importantly, infrastructure is not a homogenous asset class; no two assets are the same. Therefore detailed analysis and due diligence of the specific infrastructure asset is key prior to making an investment.
About the author
John Julian, Portfolio Manager - Core Infrastructure Fund, AMP Capital